WE are in a way fortunate to experience what normally happens once in a lifetime.
It is not often we see multiple events playing out at the same time to create what is define as a perfect storm. This storm has been building up over the past couple of months but it intensified over the past two to three weeks as markets went into a tailspin while governments struggle to contain the impact of Covid-19, which is now define as a pandemic by the World Health Organisation (WHO).
The year 2020 started out with a calm environment where investors saw bright prospects ahead to the point that we felt we had near perfect vision of the global economic outlook as economies were on a sweet spot.
The first curveball that the market got in early January this year was the unexpected US strike on Iran’s top security and intelligence commander. Although the oil price spiked past US$70 per barrel on fear of a potential retaliation, the markets escaped the fear factor as some sort of common sense prevailed that avoided what could potentially lead to an outright war.
After all, which US president doesn’t go to war, especially ahead of a US presidential election? Then the market got a lift as the United States and China entered into phase one of their trade deal. This led markets to become very comfortable to the extent the outlook for benchmark interest rates were more or less status quo as the economic growth outlook was well balanced with inflationary expectations. The Fed and the market were in-tune with each other as both did not foresee any rate hikes or cuts for the year.
The second curveball which slowly turned out to be a black swan event for the market was the coronavirus or what is now known as Covid-19. Slowly but surely the number of cases and deaths rose and by the time we were in the midst of celebrating the Lunar New Year towards the end of January, markets became occupied on the strength of the spread of the virus not only in China but outside China.
The numbers kept growing and we are now at the pandemic stage as the Covid-19 has reached more than half of the world with reported cases nearing 135,000 and deaths at almost 5,000 at the time of writing. The impact of the Covid-19 is significant. In a globalised world, the supply chain gets disrupted, goods can’t move from point A to point B, consumers are not going out to spend or neither are they keen in eating out, businesses have suffered, globally, and economic data points are beginning to show.
JP Morgan Global Composite PMI Index for February 2020 plunged to a new 129-month low at 46.1 from 52.2 in January, while the JP Morgan Global Manufacturing PMI for the same month sank to 47.2 from 50.4 in the preceding month. A reading below 50 suggests that both the global services and manufacturing activities are now in contraction.
Of course, the Chinese indicators are at the worse levels, mainly due to the world’s second largest economy being the epicentre for the spread of Covid-19. Both the Chinese manufacturing and non-manufacturing PMIs plummeted to just 35.7 and 29.6 in February 2020 from 54.1 and 50 respectively in the preceding month. The release of the trade numbers out of China for the months of January and February were mixed. While the combined two-month exports fell by 17.2%, which was more than market expectations of a 15.2% decline, imports only fell by 4% against forecast of a 16.6% plunge.
As if the Covid-19 has not caused enough damage to markets, we had another black swan event to deal with, this time from oil. Over the last weekend and before markets opened on Monday, the unexpected happen as Opec and Russia failed to agree on further production cuts to stabilise oil price and as a result, neither Opec nor non-Opec members (loosely defined as Opec+) are now restricted on their level of output.
With the output cut level of 2.1 million barrels per day to be removed by the end of the month, it is likely that oil producing nations will flood the market, led by Saudi Arabia, especially after it cut the premium of its selling price by US$6 to US$8 per barrel against the official selling price (OSP).
In fact, the Saudis already announced that they will pump up to 12.3 million barrels per day starting next month, which is 2.7 million barrels per day more than its current production level. Oil prices tanked as much as 30% – the worse one-day drop in three decades.
As oil is a significant input to the economy globally, this led to selling pressure across all asset classes, as other than safe haven assets, everything else was going down.
Thirty-year US treasury yields fell the most (meaning price gained) as yields dropped a staggering 59 bps intraday to as low as 0.699% on Monday – the largest drop ever, before bouncing back and was last seen at 1.43%. The US stock market also plummeted with the Dow down more than 2,000 points twice this week, which is clearly unprecedented as far as the index point value loss is concerned.
In fact, the Dow dropped to the bear market zone in barely 20 market days! Indeed market volatility has spiked significantly over the past three weeks with the VIX index – which is a measure of fear, rising as high as 75 on Thursday – a level last seen during the height of the Global Financial Crisis in 2008.
The US markets have been so volatile the past three weeks that we have observed the top three of the largest top five index point gains ever last week and on Tuesday, while four out of the top five index point loss ever occurred within the last 11 trading days, of which the top three largest index point loss occurred this week itself. The Dow has swung up and down in quadruple digits eight times in the last 14 trading days.
What does all this mean for Malaysia?
Other than the two black swan events mentioned above, Malaysia also observed a political roller coaster ride over the past two-three weeks due to the change of guard at the top with a new coalition emerging from the ashes of the Pakatan Harapan. Said to command support of at least 113-114 members of Parliament (MPs), we have now witnessed for the first time in the nation’s 63-year history a change in federal government occurring not due to general election but by show of support of the prime minister to the Yang di-Pertuan Agong.
Unprecedented as it seems, we do have a new government and a new Cabinet has just been sworn in as well. With the change of guard, it is left to be seen as to what new policies will be implemented by this new coalition, although it is likely that previously announced Budget 2020, Shared Prosperity Vision 2030 and the RM20bil Economic Stimulus Package will be continued.
With the house in order, the new Cabinet has its work cut out, especially for the new finance minister, the minister in the PM’s department (economy), the international trade and industry minister and the health minister.
For the finance minister, the oil price collapse brings a new challenge as even if oil were to average about US$30 per barrel this year, the government’s revenue will be reduced by as much as RM9.6bil or about 0.65% of the annual GDP. Hence, the government’s fiscal balance will be further constrained with the budget deficit likely to hit 4% instead of the revised 3.4% following the RM20bil stimulus package announced by the previous administration.
While the RM20bil stimulus package was seen as positive, we must also take note that about half the amount is due to the cut in the rate of contribution from 11% to 7% on the employees’ portion of the Employees Provident Fund (EPF). There is also an option for employees to maintain the original rate of 11%.
The issue here is how many active contributors will opt to maintain the current rate of 11% and for those who have higher take-home pay, how much of that higher disposable income is going to trickle into generating economic momentum via their consumption habits?
We can safely assume the 80/20 rule will apply here and hence we perhaps need to discount the impact of the RM10bil enhanced disposable income due to the cut in EPF rate by 36% to RM6.4bil – meaning 20% of contributors will likely opt to keep the original 11% rate and for those who have higher disposable income due to the lower EPF contribution rate, only 80% of that extra disposable income is actually spent on consumption.
With the economic momentum easing, now made worse with falling commodity prices, the government will have no choice but to recalibrate Budget 2020 with revised estimates and, better still, with more measures to withstand the economic headwinds.
Here are five suggestions for the new finance minister aimed at addressing concerns of the low-income group, especially the wider B40 group, the private sector and SMEs, as well as the financial markets:
> Introduce e-wallet credit for 3.8 million Bantuan sara hidup (BSH) recipients of RM1,000 each with a six-month expiry date. This will cost the government RM3.8bil, but the positive economic impact will be great as the extra liquidity will be generated from the purchases of consumer goods and services. This will not only help households to ease the pain from the slowing economy but re-ignite the retail sector as well, which has been badly hit by Covid-19. For BSH recipients without an e-wallet account, a voucher with a six-month expiry can be an option, instead of direct cash.
> Reduce the corporate income tax rate for 2020 by four percentage points to 20%. The lower tax rate could see corporates reducing their tax liability by about RM12.5bil (based on Budget 2020 estimate) and this could boost the net earnings of companies, which in turn could see them providing higher dividends to shareholders as well as boost consumption and investments.
> Set up a RM30bil equity fund to be equally owned by institutions like the EPF, Khazanah, KWAP, Tabung Haji, LTAT and Socso. With the FBM KLCI now hovering near 10-year low, this is the best time to set-up a new equity fund that could withstand the onslaught of foreign selling which has been relentless in their selling pressure on the local bourse. Year-to-date, the net foreign selling has already reached RM4.73bil (up to 12 March) and this is on top of the RM11.14bil net outflow last year. With the FBM KLCI now hovering near 10-year low, it is an opportune time to intervene in the market and to support fundamentally sound companies with great business model as well as good governance and reasonably high dividend yields.
> Provide a RM2.22bil new infrastructure fund to be spend on small projects across the 222 parliamentary seats. This RM10mil per parliamentary seat allocation must be spend within 2020 to help local businesses as well as construction and building materials industry. Small projects could be for new roadworks, bus stops, libraries, government clinics, bridges and so forth.
> A RM1.5bil standby short-term credit facility with 2% interest rates for SMEs. This fund can be managed by the banking sector to be disbursed to SMEs who are in dire need of operating cash flows during these trying times.
The above five measures costing some RM20bil directly to the government will indeed result in higher budget deficit compared with the revised forecast of 4%. The RM20bil package will add another 1.3 percentage points to the nation’s budget deficit to 5.3% but this can be address reasonably well given the global economic conditions. In fact, almost all countries are doing some sort of measures to cushion the economic impact from the Covid-19 as well as slowing economic momentum.
The question now is how do we fund the additional RM20bil stimulus package? The straight answer would be further government funding via the fixed income market but the government could also tap other resources, especially special dividends from Petronas, again.
With the first RM20bil stimulus package plus the above five proposals, Malaysia will stand out internationally as having a government that cares for its people and to ensure the economic fallout from three unprecedented black swan events are well addressed.
Clearly, the market and economic turmoil is taking its toll on all of us and we need to have strategies to counter the storm. For investors, this may be a good time to look at some bargains out there after the recent sell-off but be mindful at the same time to not catch a falling knife. As Warren Buffett says, be fearful when others are greedy and be greedy when others are fearful. Perhaps it’s time to be greedy instead of fearful.
The views expressed are the writer’s own.